Expert Advice for a Wall of Worry

Even when the markets seem generally positive, investors seem worried, even distressed. And that brings to mind an ancient and venerable market epigram. It’s the old saying, “Markets climb a wall of worry.”

It’s a bizarre image if you’re new to the stock market, but there’s some real meat in it if you think about it. 
 
What the saying means is that a bull market isn’t a peaceful place. When the good times are rolling, investors are constantly tense, wondering how long they will keep rolling, fretting about whether a correction in a particular stock is going to turn into a rout and agonizing over whether to take profits in a position or let it ride.

Experts and commentators do their part by issuing warnings about everything that could possibly go wrong with the economy, the markets and most leading stocks. And, as always, economists can be counted on to give conflicting predictions that arrive at diametrically opposite conclusions from exactly the same data.

As our long-time subscribers know, we take all predictions about the future with a grain of salt almost as a religious principle. Thus, we are released from the responsibility of trying to sort out who’s likely right and who’s wrong.

And yet, along with every other equity investor in the world—professional or amateur, individual or group, dabbler or heavy hitter—we live on the wall of worry, too. As mutual funds love to keep repeating, “Past performance is no indication of future results,” which they usually follow up with “May lose money.”

Since we don’t actually invest other people’s money, we don’t have to say the little “past performance” mantra to stay on the right side of the law. But we have to live with our results, nevertheless. And unlike mutual fund managers, we have to answer to our subscribers in a very direct way.  

But here’s the rub. We all may worry, but you’re the one who has the money at risk. And that means that you must be prepared to manage your own portfolio. And to do that you need a few rules.

Rule #1:  Cut Your Losses Short. This should probably be rule #2 and #3, too.  Nothing is as important as avoiding big losses. The portfolio of Cabot Emerging Markets Investor has one big guideline, which is to sell any emerging markets stock that hands you a 20% loss from your buy price. That’s the rule when the Cabot Emerging Markets Timer is positive. When the Emerging Markets Timer is negative, the loss limit is narrowed to 15%. This is a maximum loss limit, and nothing says you can’t sell more quickly if a stock shows signs of deterioration. And finally, your buy price may be different from our portfolio’s, so you can’t just rely on the portfolio’s buy and sell recommendations. (Note that all calculations of both profit and loss are based on closing stock prices, not intra-day moves.)

Rule #2: Let Your Winners Run. While there’s something to be said for taking partial profits and selling some shares on the way up, Cabot Emerging Markets Investor is an aggressive growth investing advisory, so we’re looking to maximize gains. And the biggest gains come when stocks keep on growing. The ideal of selling at the top is just that, an ideal. It doesn’t exist in the real world except by luck.  

Rule #3: Stay On the Right Side of the Major Market Trend. The Cabot Emerging Markets Timer tells us the general health of emerging markets stocks, and flashes either a red or green light depending on whether the moving average of the Halter USX China Index is above its 25- and 50-day moving averages or below them. Staying fully (or even heavily) invested when the China Timer turns negative is like swimming against the tide. It’s just not a good idea and your chance of success is substantially reduced.

That’s it. Three simple rules. They have served us well in the past and we are cautiously confident that they will serve us well going forward. We will continue to climb the wall of worry, of course, but that’s just the nature of the game.

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